The Weaponization of Consumer Finance
2022-12-19 · Guest: Todd Zywicki (George Mason University School of Law) · 52:46
Government Control and the Consumer Credit Market
Bob Zadek interviews Professor Todd Zywicki about the shift in consumer credit from a competitive private market to a government-controlled system. They discuss how government mandates like the Community Reinvestment Act and initiatives like Operation Choke Point use the banking system to enforce social policy and punish political dissent.
Topics: Consumer Credit, Banking Regulation, Operation Choke Point, Community Reinvestment Act, Usury Laws, Credit Rating Agencies, Financial Freedom
Speakers: Bob Zadek, Todd Zywicki
Introduction to Consumer Credit [01:01]
Bob Zadek: Hello friends, I’m Bob Zadek, host of the country’s longest-running libertarian broadcast, nationally streamed at 8:00 AM Pacific Time Sundays on the 860 AM app. My Bob Zadek Show podcast archive holds about 15 years of major issue discussion and is the ideal resource to remind us of our past errors, especially since many are still with us. I promise you in-depth content on social, political, and economic issues that really matter, always with the ideal guest, accessible and entertaining. Our standard: ideas, not attitude.
Today’s guest, Professor of Law Todd Zywicki at George Mason University School of Law and co-author of Consumer Credit and the American Economy, exceeds those standards. Not too long ago, consumer credit was extended by many businesses competing to extend credit to consumers through unsecured lending, auto loans, home mortgage loans, or installment sales. There was true competition. Not any longer. Today, in today’s consumer lending environment, businesses are nothing other than agencies of federal and, to some degree, state governments acting under the veneer of a private business. They have an unholy alliance with government. The business promise: “We will do your political bidding. We will give you political cover so you can carry out the social policies you wish. In exchange, Ms. Government, you will make sure we never lose any money.” And that pact has been honored by both to the detriment of us naive consumers. To help us understand this dynamic, how we got here, where we go from here, and how to spot it when it happens, I’m delighted to welcome Todd Zywicki back to our show. Todd, thank you so much for joining us.
Todd Zywicki: Thanks, Bob, and thanks for that wonderful setup, which I think is a brilliant summary of where we are today.
The History and Importance of Credit [03:52]
Bob Zadek: Now, Todd, consumer credit—consumer credit is a huge element of our domestic economy. So listeners of our conversation today, while of course they have a very personal self-interest—most, probably all, are users as customers of consumer credit: home mortgage loans, auto loans, payday loans, unsecured credit, credit card debt, and on and on and on. Our economy would be really in the dumpster without the addition of the additional buying power given to consumers because they can spend more than just what they are earning in the past week or in the past month. Give us a sense of, just to get us into the ballpark, how important the extension of consumer credit is in our economy, and then we will drill down and try to sort out what’s wrong with it.
Todd Zywicki: What a terrific question, Bob, and that’s really the theme of our book that you mentioned, Consumer Credit and the American Economy. Most people don’t appreciate that the great migration to the suburbs after World War II was fueled by consumer credit. When people left their apartments in the city and moved out to Levittown, they took a mortgage, and they needed a car, and furniture. As you said at the outset, that was all funded by car dealers, by department stores, by furniture stores, by appliance companies. And people weren’t paying cash to buy that three-bedroom house in Levittown with the new Buick in the driveway. And that has continued since then. Consumer credit is really a powerful vehicle for consumers to be able to acquire goods and then use them. Think about something as humble as a washing machine. That may be the best investment you ever make in your life. The alternative to buying a washing machine is schlepping to the laundromat every weekend with a pocket full of quarters and sitting there waiting for your clothes to wash. And so what we don’t appreciate is a lot of these are capital goods—whether cars or houses or student loans, they’re capital goods that make sense for consumers to buy on credit as a form of an investment and a form of saving as an alternative to renting and that sort of thing. And it really fuels the economy and it really empowers consumers to make their lives better.
The Three Classes of Lenders [05:41]
Bob Zadek: Now, there are—we can break down the consumer credit economy into three classes of the providers of credit, the lenders, if you will. There are three classes. Todd and I look back teary-eyed to when there were businesses, real businesses that struggled to make a profit and retain customer loyalty and enjoyed a positive reputation in the world lest they lose their customers. There were businesses, remember them? Because they’re fading, so hold on to those memories; they’re not going to be reinforced. Then there is government. As we all know from the daily update on the student loan issue, government is the 800-pound gorilla in the area of consumer credit, both directly—and we’ll discuss both—the government as lender, and the government when they’re not the lender, they are the board of directors of all the lenders telling the lenders how to do it. So they are there one way or the other. So we have private lenders—not anymore—we have government butting into private lending. Todd will explain that in detail. And of course, we have—since the demand for consumer credit will always be there—if that demand is not met by businesses or government, it’ll be met by the black market, the street, the loan sharks. But one way or another, consumers will of necessity, not of choice, of necessity find a way to get the money they need to go about with their lives.
So we start with the past: private lenders. But those days are over. So Todd, trace, show us very briefly—because this is not the primary lesson of today’s show, but I want to sort of put the audience into the environment—so tell us how far away from the activities of a private lender we are today. And I’ll remind you, Todd, or remind the audience, that the activities of being a private lender and making a profit are easy. You’re making loans—that’s the product. But as I learned when I first ventured into lending—and I have a lifetime of lending and representing lenders—as I learned, you don’t have to be that smart to make a loan. Getting paid back is a bit trickier. So therefore, you don’t have to be a genius to get a total stranger to take your money. You don’t have to be that persuasive. Getting it back, you’ve got to know what you’re doing. Okay, so if you’re a private lender, you’re in the business of making loans to people who will pay it back. And in the ideal world of the marketplace, if you price your product higher than one of your competitors, you will not have any business. So a lender has to price the product in a way that they make a profit or else they will fail. And in making a profit, one of the costs of a business—profit equals income minus expenses—the expense of a lender is bad debts. Because if somebody doesn’t pay you back, that becomes an expense. So a lender in running the business must manage the expense of bad loans. So as you can see, it’s not that hard. That’s the process: lenders make loans to people who will pay it back at a price that’s lower than the competition. Pretty straightforward stuff.
Now, but that doesn’t happen anymore. So Todd, tell us how—and I’m going to ask you a two-part question, both important. Number one, how far from that idyllic Main Street model are we today with consumer lending? And why has government chosen to become as involved as they are in basically a consumer service?
Todd Zywicki: Yeah, it’s a terrific question. Why does the government put their hands so much on finance when they don’t design cars? They don’t design blue jeans. But they feel perfectly comfortable designing a lot of the terms and conditions of loans. To start with your first question, how far from that? As we were just talking about a minute ago, we now really understand why consumers use consumer credit. The demand side of the equation, as I said, is to acquire what we can think of as capital goods. It makes sense, for example, to have a mortgage on a house. It doesn’t make any sense to save up for a house, pay rent while you’re doing it, and then buy a house in cash. Same with a car. People don’t appreciate this, but one of the main reasons why General Motors overtook Ford as the largest auto dealer was not just because of the stylishness of their cars, but in the 1920s, General Motors rolled out the GMAC plan, which allowed people to buy the car and drive the car while they were paying for it, right? Otherwise, you could save up for the car, but in the meantime, you had to take the bus. And so if you understand why these are capital goods, that makes sense. The other reason people use credit is to deal with emergencies, short-term fluctuations between income and expenses. So that’s the demand side.
The supply side consists of basically two things. The first thing, as you said, is bad debt. If you have more bad debt, then you lose money. The other thing is just the cost of lending. And this is something a lot of people don’t appreciate, which is a lot of the cost of lending is unrelated to the size of the loan. So for example, it doesn’t cost a hundred times more to make a $30,000 car loan as opposed to a $300 payday loan, right? You’ve got overhead, you’ve got operating expenses, employees, electricity, all that sort of stuff. And so this is why small-dollar loans just are more expensive than say a credit card loan, just because they’re smaller, they’re expensive, they have high loss rates. It all makes sense from an economic perspective. But people just kind of switch off their economic thinking about this. Over time, what we’ve seen, as you mentioned, is a lot of this has migrated away from traditional sorts of credit to financial institutions.
Usury Laws and the Black Market [12:29]
Todd Zywicki: Back when we had usury regulations, which you mentioned, that kept ordinary consumers from getting access to a lot of good credit, whether it was car loans or credit cards or whatever. A great example was Arkansas in the 1970s had very strict usury ceilings. Consumers basically couldn’t get a credit card in Arkansas. It was also the pawn shop capital of America, which is pawn shops were three times more prevalent in Arkansas because people have a need for credit, but you have a demand for credit but not a supply. You can’t wish away a need for credit. And that gets to your other point, which is if consumers can’t get credit through organized competitive markets, they still need credit. And this is, you know, Tony Soprano isn’t just a myth. In the 1960s, for example, there was a Senate report in 1968 that said that loan sharking was the second largest revenue source of the mafia. It was estimated around 1970 by an FBI agent that there was about $10 billion a year in illegal loan sharking, which in today’s dollars is about $69 billion. To give you a sense of $69 billion of illegal lending by the mafia, the entire payday loan industry in America today, online and bricks and mortar, is about half that, $34 billion, right? That’s what we had back in the day when we had these strict usury regulations that stifled competition and consumer choice. And so what we learned is a cycle to get to your point about how did government get so involved. In the past, whenever the government would get involved by imposing these usury regulations, by imposing price controls, what we would get is a black market. What we would get is the loan sharks would take over. The government would be basically forced by market forces to do that. And so eventually what they did is they moved away from usury regulations, but now what they’ve done in many ways is almost worse, which is kind of gotten their tentacles into the supply side of lending in a much more intensive way to try to control the other terms and conditions even if they leave the prices alone.
Bob Zadek: And just a couple of comments. You mentioned Arkansas and pawn shops. Pawn shops are, of course, lenders. That’s what they do. It’s dressed up as you’re selling something with a right to buy it back at a higher price. The higher price is the interest. So it’s a loan secured by a guitar. I mean, that’s what a pawn shop is. So Arkansas on the one hand can proudly—or the Arkansas politicians in the day could proudly boast—“We are protecting our consumers from paying too much interest.” But the pawn shop rates were somewhere around 128% per annum, something like that, although they don’t lend itself to a precise calculation. So it gave political cover and some bragging rights to Arkansas politicians, but the consumers were simply sent to 128% per annum transactions because it was illegal to lend them the same money at 42% because that was usury. Go figure. And of course, the reference to organized crime or even disorganized crime, loan sharking, is of course a common story. We all know that. Prohibition, narcotics, opioids, gambling—when government prohibits an activity that people are determined to do, the people will always do it. Except they do it underground, which means the cost of doing it underground is higher. So there is no such thing as prohibiting an activity people want to do. You cannot legislate morality; it’s impossible. And so Todd raises an important but unsurprising dynamic. Of course, if you regulate the price of something or ban its purchase and sale and people want to do it, darn it, they will find a way to do it. Government will not succeed. They will succeed in only converting people who are not criminals into criminals just because they want to do something that doesn’t hurt anybody else. And that’s the dynamic.
Government Mandates and Increased Costs [17:29]
Bob Zadek: Now, Todd, in the area of consumer credit, the interest rate—one would imagine if you’re a private business, you are torn. You want to make as many loans as you can, but more importantly than making a loan, as I said, not jokingly, is getting it back. And therefore, you want to manage all your expenses, including the expense of not getting it back, the bad debt expense. Which means if you’re a lender, you are determined to lend money to as many people as you can so long as they can pay it back. And therefore, you set the interest rate as high as you possibly can, but the market dictates that if you’re making too much money, you will draw competitors, which will cause the price to come down. So the marketplace is the upward brake on how much you can charge. And on the downside, you can’t charge too little because you go out of business. Now, what has happened? Trace or give us some examples of how government has mandated an increased expense, has said to a lender, “You must increase your bad debt expense because that accomplishes a social goal.” And then we will determine what happens to the rest of us when government does that, and characterize, if you will, the economics of government telling a lender, “For reasons of our political goals, you must make a loan that your credit judgment is the loan is not likely to get paid back.” Tell us examples of that and what happens to the marketplace for lending.
Todd Zywicki: Right, that’s exactly right, which is, Bob, they can pass all the laws they want, but they can’t repeal the law of supply and demand and they can’t repeal the law of unintended consequences. And there’s a supply and demand, there’s a market here just like there is for anything else. And you start fiddling with the pricing in that market and you’re going to end up either drying up the market, meaning people won’t be able to get access to credit or some people, or you’re going to have the products repriced. So for example, what most of us who are our age will remember is that credit cards, every credit card basically used to have an annual fee on it. Now, why was that? It was because of usury regulations. You couldn’t charge a market rate of interest, and so what would happen is that lenders would compensate by just charging you a fee in order to have a card, $40 or whatever. So what we had was people who, by usury regulations, you were basically having people who paid off their bills every month subsidizing those who borrowed, which is sort of a weird sort of goal.
The Community Reinvestment Act (CRA) [21:54]
Todd Zywicki: And so I think what most people would be familiar of a good example of where this goes awry ends up being, as many people are familiar during the financial crisis, the Community Reinvestment Act, for example, and the requirement that banks do a certain amount of political lending to sort of favored groups by the government. And what we know is that those loans, you know, loans that were made, have a higher loss rate. And that those loans then as a result end up washing through the system.
Bob Zadek: Todd, I’m not trying to say something to disparage my highly educated audience, but I dare say there may be people out there who don’t really know and despise with the same depth that you and I do the Community Reinvestment Act. And that actually started in Chicago, as I recall. It started as an experiment in the city of Chicago, and that became, as I recall the history, the CRA. So tell us just in a really short paragraph, because it was the first big example of this requiring regulated lenders, aka banks, requiring banks to make loans that a bank might not otherwise make, and the effect on all of us of that legislation. Just tell us the bullet points of CRA.
Todd Zywicki: So, because it has kind of become the model, as you suggest, for subsequent political interventions into the financial system, which is the Community Reinvestment Act is intended to solve a prior problem the government caused, which is the problem of redlining. And the evidence is pretty clear that what was redlining was the idea that there were certain neighborhoods that banks wouldn’t lend to, which were predominantly minority neighborhoods. Now, where were these so-called redlined neighborhoods? Where did that come from? It came from the federal government’s housing agencies basically identifying certain neighborhoods as being high-risk neighborhoods, which were basically defined by their racial demographics. And so, as you said earlier, in a competitive market you don’t get that. But where you have the government basically regulating banks, telling them where they can lend and that sort of thing, you can get something like redlining. So what we ended up with was decades of federal government discriminatory housing policy that created disparities in the market. And so the way they decided to make up for that was basically to tell banks that they had to start making loans in a lot of those neighborhoods without applying the same sort of underwriting standards that they apply to other customers. And so what we get is basically government policy that creates redlining, creates a racial discriminatory market, followed by another government policy that is designed to overcome, to rectify the prior government policy by now turning those into favored neighborhoods where people are subsidized. And then you end up with these issues of bad debt and the like.
Bob Zadek: And what happens is, of course, so now you have a bank which is required—and when I say required, the way a bank is required is banks need to go to Washington and seek favors all the time. A bank wants to acquire another bank; they need approval. The approving agency will say, “Not so fast, Ms. Bank. Before we give you a consent that you want to make more money, let’s see how you’re doing on making loans to our politically favored groups.” And if you have a low rating for CRA, then we just may say no. So there’s a lot of coercion because of regulation that banks have no choice but to make loans, A, to borrowers they otherwise wouldn’t make a loan to for credit reasons, not for racial discrimination, or they would make a loan but they would charge a higher rate than the government air-quote permits them to make. Which means the bank’s expenses go up. Well, if the bank’s expenses go up and the bank is determined to make a profit, what must they do? They must raise their rates, which means all you listeners are now paying a quarter of a point more for your home mortgage to cover the increased expense, bad debt expense, which a bank incurs because they are ordered to do so. So notice what has happened. It’s been a wealth transfer. By dint of CRA-type legislation, consumers who pay their bills promptly or pay their loans promptly are paying a higher rate of interest to underwrite and subsidize the cost of consumers who don’t. And it’s insidious but it’s profound. Now, we have used it, Todd, as an explanation of CRA. But CRA in that dynamic is not alone, is it?
Todd Zywicki: No, not at all. And this has become increasingly common by the federal government. A good example of this was during the financial crisis when the government basically took over Ally Financial, you may recall. They had a majority stake in Ally Financial, the former General Motors financing arm. And Ally wanted to become a bank holding company, and they needed approval from the Federal Reserve. And basically what happened was the CFPB held it up, basically extorted a settlement out of the company for discrimination without very questionable evidence to support it. The company has said subsequently that they were basically bullied into it. But basically what it was is they used this leverage of holding it up because of these discrimination-type ideas. And what we’re seeing now is that in the wake of everything that happened with George Floyd and all this concern about racial justice and that sort of thing, what we have seen increasingly over time is that this is spreading. And the idea is basically to conscript private banks to essentially carry out this social policy. And as you said, basically use this idea of a wealth redistribution system through the financial system for the federal government to essentially avoid doing an off-budget transfer, as you said at the outset of the show. They basically use banks as a piggy bank to accomplish things that the government doesn’t want to spend money on or take credit for directly.
Bob Zadek: Actually, you said off-budget. I winced a little bit, Todd, because that puts too positive a gloss on it. That sounds like we are talking about an accounting issue. But what’s really happening is if government—if government decides to take money from one group to give it to another group, they know how to do that by direct legislation and call it the 2023 Wealth Transfer Act and do it. But that’s politically uncomfortable. It’s much better, and government’s far too insidious to do it directly. So my comment is not that the wealth transfer is somehow bad—I don’t want to get into that—I’m discussing only the method. Once you are determined to do that, do that upfront and out there in front of your voters and let the voters decide if they support your worldview in doing that.
The Weaponization of Credit Ratings [29:06]
Bob Zadek: Now, Todd, in your book, and you have also in your appearances in media, you have called attention to another aspect of consumer lending which is becoming socialized. That is to say, it’s becoming the function which should be a private business activity is becoming co-opted and being transferred to a governmental function. And it affects every single person with a coin in their pocket. And that is credit—the credit rating agencies. You have written extensively and spoken about credit rating agencies. They are kind of invisible except people are told by their credit card issuers, “Hey, your credit rating just got better, check it out.” So consumers know about credit rating from that. And I dare say the perception is that there’s some objective evaluation of how you have behaved as a debtor. But it’s far darker than that and getting much worse. What is happening—because this is new news we can use—what is happening in the area of this boring area of credit ratings?
Todd Zywicki: This is, as you said, a behind-the-scenes, under-the-radar issue that people really need to know about. Now, why do I say that? Because it turns out our modern credit reporting system in this country and credit rating agencies is a miracle. And I’m not understating it when I say it is a miracle. We talked about the migration to the suburbs, we talked about the American dream, and what really fueled that was the adoption of these modern credit rating agencies, these ways of collecting information. Now, why is that? The main reason is because prior to the widespread use of credit reports and credit ratings, basically what you had was you could get a loan if you played golf with the bank manager, right? If you went to church with the bank manager, right?
Bob Zadek: If you were white. If you were white.
Todd Zywicki: Exactly right. But the ordinary Joe, the guy who, you know, the immigrant, the new guy, that sort of thing, who was a good, reliable person who worked hard and could pay their bills but weren’t connected, had no way of proving their creditworthy status. And so what credit ratings basically allowed, it enabled the ordinary person to essentially prove that they were creditworthy. In fact, the great growth in the use of credit rating agencies came about with the passage of the Equal Credit Opportunity Act. And women were the ones who primarily lobbied for greater use of credit reporting. And so what it is is the accuracy of credit reporting and the accuracy of what goes into those files is essential to, most importantly, people who are on the periphery, right? Young people, people who don’t have connections, people who don’t have experience, people who can’t, you know, to be able to show that they can be trusted to get a mortgage, to get a car loan or something like that. And what we’re seeing is more and more of these political assaults on credit rating agencies designed to politicize them, to redistribute wealth, but in the long run, what it does is it ends up undermining the accuracy and the value of those systems, which ends up interfering and harming those who supposedly are being helped the most by this.
Bob Zadek: And the credit rating agencies, they only have their service purchased if it is proven to be accurate. Credit grantors, large consumer credit grantors, have a way of relating bad debt losses to credit ratings. And there is more than one—there’s not dozens, there’s a few credit rating agencies. And if those ratings that the agencies give, as you compare them to bad debt losses, if you find that one agency’s rating produces a higher loss ratio than another’s, you will determine the credit agency has a bad algorithm, their methodology is wrong. So the proof is in the pudding. And now governments once again have discovered that credit rating agencies can be used to give credit, which means money, to recipients who might not deserve it, so long as the method of rating the borrower can be manipulated. So tell us what you fear is starting to happen in the—we like to think—objective and certainly not racially motivated—that’s absurd to imagine that—area of credit rating.
Todd Zywicki: Yeah, that’s the—and there is this kind of funny irony, which is that they want to say that banks are these greedy guys, yet at the same time they don’t want to make loans to valuable customers because of discrimination, right? But what they’re doing now, they’ve talked about one of the persistent issues is that there are differences, sort of chronic differences in the credit scores between white and minority borrowers, right? Or more precisely, Asians have better credit scores on average than whites, and blacks and Hispanics have credit scores that are not as good. And what a lot of people have said, well, that’s just evidence of systemic racism, right? And so what they’ve decided needs to be done is that we essentially that we need to manipulate the credit scores so they all come out to be the same, right? And that basically means taking what are these electronic systems, these algorithms that are designed specifically just to identify what variables will best predict whether somebody will pay their loans, and reconfigure them so that they make it possible for racial redistribution within the system. I’ll give you one other example that people haven’t focused on is a desire to fiddle with the reporting of medical debt. And what this really is is part of a long-term effort to move to a single-payer healthcare system by basically making it really difficult to bill and collect medical debt over time. And I think that is, you know, if we want to have a debate over single-payer healthcare, let’s do that, but let’s not do it through the back door by basically making medical practitioners unable to collect debt for services that they’ve provided.
Bob Zadek: As you were explaining what’s going on where government has their sights on fiddling with credit ratings, you could just as well have been talking about admissions policies in major universities. It’s the same conversation. It’s the objective examination which doesn’t let enough of a politically favored group, therefore the problem must be in the selection process, although it’s objective. Now, of course, university admission systems are far from objective. There’s a lot to be criticized in admission policy. So this is not a love song towards admission policies, but it’s the same process. You start with the result: “We need to change the result. How do we change the result? We fiddle with the criteria.” But when you fiddle with the criteria of who can pay back a debt, that’s nothing other than saying the credit rating policy discriminates against people who don’t pay their debts. Well, yes, that’s kind of the purpose. So that’s what’s going on in credit ratings.
Operation Choke Point [42:38]
Bob Zadek: Now, once again, just explain to our listeners why they care, how it will adversely affect somebody who gets sufficient credit and goes about their business life, their commercial life, borrowing what they need at whatever rate the market will charge. Why should the average consumer care about the government fiddling in underground garages, if you will, with trench coats on, fiddling with credit rating policy of the major credit rating agencies? Why does the average consumer care about that as the government goes about doing it?
Todd Zywicki: Yeah, and let me make it clear, Bob, first, that like many other areas of our history, there was racial discrimination in the financial system, right? But the important point to recognize is that discrimination was a byproduct of government regulation. That came about because of government policies by housing authorities that pushed for redlining. That came about as a result of things like usury regulations that made it impossible for lower-income people generally, but specifically minorities, to be able to get access to credit. That came about because of usury regulations that made it impossible for personal finance companies to be able to operate. The answer has always been the private market. It has always been banks, it has always been private lenders looking to identify untapped markets of creditworthy borrowers to whom they could lend money and get paid back. And why does it matter? Because when some people don’t pay their loans, the rest of us have to pay for it. In order to make a loan, you need to either be able to price the risk effectively or you have to reduce your risk of loss. And that means either you raise interest rates or other costs, or you have to just not lend to some people. And in particular, who loses? People who have the weakest credit reports, people who have the weakest credit rating are the ones who end up losing. As a result, they are the ones who end up in the hands of the loan sharks.
Bob Zadek: Now, your book explains in great detail, and it’s intensely data-driven, the government messing around with a private activity of the granting of consumer credit. The government in its nationalization—because that is what happened—of the banking system. Banks used to be truly, or for the most part, private businesses operated as a private business with their deposits guaranteed, consumer deposits guaranteed by the federal government under the Federal Deposit Insurance Act. All that we’ve long since accepted. But of late—and what I’m leading up to, Todd, so you can explain, is I’m leading up to what Todd will explain as Operation Choke Point. Banks—the government has learned from none other than Lenin and Marx that all you need to do as a government is control the financial system and you control the entire country. And that’s all you need. You don’t need a lot of armed weapons and you don’t need a force. All you need to do is control the banking system. And that process started with reducing the number of banks. It’s easier to control a smaller number of banks than a large number of banks. And of course, the banking system used to have perhaps 15 or 16,000 banks. Now we’re down to less than half of that. And many people believe, including me, that’s not an accident or just mere consolidation. That’s a matter of policy because it’s easier to control a few large banks than a zillion small banks.
On top of that, the government, which now insures the deposits, now has a stake in the solvency of the banks. And the governments have a tool, which is they require banks to behave in a way that doesn’t threaten them. And the usual tool government uses is they determine that an activity of the bank jeopardizes their reputation and in doing so, it threatens their solvency. All of that, Todd, is an introduction to Operation Choke Point, which we thought had gone away, but it has not. Explain to us, start with that introduction that I gave and explain Operation Choke Point and how it fits into this discussion of consumer credit.
Todd Zywicki: Yeah, I think that you’ve framed it well at the outset, Bob, which is we live in a different world here, right? Those of us who consider ourselves libertarians, we’ve kind of always thought in terms of this binary that goes back and has served us very well in thinking about the world for centuries, really, which is you’ve got private business on one hand, you’ve got public government on the other, and that the threat to liberty in some sense comes from the government and not from the private sector. But what we see now in the world of the administrative state is that binary distinction doesn’t really hold anymore. And banking is in many ways the apotheosis of the regulatory state, which is banking is so intertwined with the government, starting with deposit insurance, and that kind of becomes the lever for everything that comes after. Banking is so intertwined with the government that it gives the government the ability to exercise all these informal tools over the government. And they particularly use a power called supervision, which is basically the government can go in and inspect your books and records and basically determine whether or not you’re running the bank in what they consider to be a safe and sound manner. That has been expanded over time now to include things like ESG that many people are aware of. But what many people are less aware of was what you just mentioned, the Operation Choke Point. And Operation Choke Point was an initiative during the Obama administration where the banking regulators, without any authorization from Congress, ended up basically taking legal businesses and telling banks they should not lend to those businesses. These were payday lenders, these were firearms dealers, these were fundamentally just businesses that were unpopular with the Obama administration. They weren’t just controversial, they weren’t…
Bob Zadek: It included dating services. It included dating services of all things.
Todd Zywicki: Dating services. But notably, it didn’t include say abortion clinics, right? A lot of organizations that could be thought of as controversial, but they just didn’t think of it that way. And what they used was this idea called reputation risk. And our friend John Allison, who was of course the president of BB&T Bank for a long time and later president of the Cato Institute, refers to it as regulation by raised eyebrow, which is the banks kind of look at you and say, “Do you really need to have that particular client in your bank?” whether it’s a payday lender or a firearms dealer or whatever. And most of the time the banks just knuckle under, right? And most people don’t even know about it, and all of a sudden people have their bank accounts canceled. Well, that eventually got outed.
International Trends in Financial De-banking [49:27]
Bob Zadek: It got outed and then the FDIC or the OCC denied doing it. And it was sort of like the—I did a show last week on the Dear Colleague letter from the Department of Education. It’s the same thing. It’s, “No, we didn’t tell banks what to do. We just casually expressed an opinion. We’re not crazy about bank accounts for gun dealers, even though it’s a lawful activity,” and bankers got the hint. So tell me—we’re running out of time—so tell us that Operation Choke Point, you and I thought was dead, but you have pointed out it surfaced again. And we only have a few minutes left, but in terms of government using bank accounts of all things as a weapon to attack citizens who are not breaking any law, it’s not limited to the US. And there are examples in the media: China and Iran. If you can just share anecdotally how governments are starting to use bank accounts. And I’ll say what—when I looked at this, the first thing I thought of was no-fly. Governments are using another right we all think, the right to get an airplane, and they are using it to punish people they don’t like. So we have about a minute left before we close. Tell us about what’s going on internationally about weaponizing a deposit account.
Todd Zywicki: No, that’s right, and the no-fly list is a great analogy, which is—I call it cancel culture comes to banking, which is now they’ve taken this idea and banks are now depriving private citizens, churches, non-profit organizations of bank accounts. So the Alliance Defending Freedom, for example, a number of religious liberty organizations has had a number of their clients lose their bank accounts over time. Mike Lindell, the MyPillow guy, lost his bank account for being too controversial on various issues. But this is increasingly becoming a weapon used by authoritarian governments to prevent dissent. So in Canada, for example, people may recall that Justin Trudeau used this power to stop the Canadian truckers from protesting against vaccine mandates, which is he froze their bank accounts, froze them to the extent that people couldn’t even use their own bank accounts to post bail. A judge let this one person have bail, but she couldn’t access her bank account to actually pay for it. So you can easily see how this could lead to de facto taking away constitutional rights. If you have a right to a lawyer but you can’t pay for it… Chinese have done this. Iran right now has announced that women who protest the mandatory hijab rules will get two warnings, and after two warnings they’re going to get their bank accounts frozen if they continue to persist in not covering their face in public. So they understand why they called it Operation Choke Point, because they know, they said, “We can choke off the air you need to breathe.” And that’s why they’re leveraging bank accounts as a way of basically forcing compliance by dissenters.
Bob Zadek: This is Bob Zadek thanking Professor Todd Zywicki for sharing with us his thoughts as set forth in his new book, Consumer Credit and the American Economy. It is scary how our government has weaponized something as benign and ordinary as consumer credit and access to banking. It scares the heck out of me because it’s insidious, nobody knows about it. You know if somebody knocks on your door in a SWAT uniform, but when your banker is performing the same function as a SWAT team surreptitiously, that makes me fear for our country. Todd, thank you so much for sharing your thoughts with us. Thank you to my friends out there. I hope you have felt that the hour you have given Todd and myself has been worthwhile. So thank you so much to all of you. Todd, thanks again for joining me. You’re always a wonderful guest. I sure appreciate it. And thank you to my friends out there.